AMP expenditure deletion upheld as it does not constitute international transaction under transfer pricing rules
ITAT Delhi upheld CIT(A)'s deletion of AMP expenditure additions, ruling it does not constitute an international transaction. The tribunal excluded Syngene International Limited as comparable due to unavailable segmental information but included Sequent Research Limited as valid comparable. Transfer pricing adjustments on interest receivables were deleted as revenue failed to controvert CIT(A)'s findings. For ECB interest transactions, the matter was remanded to AO for obtaining credit rating of associated enterprises, agreeing LIBOR is proper benchmarking. Raw material purchase adjustments were deleted as assessee demonstrated healthy gross margins at arm's length price.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Tribunal in these appeals spanning Assessment Years (AY) 2013-14 to 2016-17 include:
- Whether the Transfer Pricing Officer's (TPO) and Assessing Officer's (AO) determination of Arm's Length Price (ALP) for international transactions, particularly relating to contract Research & Development (R&D) services, purchase of raw materials, payment of interest on External Commercial Borrowings (ECBs), Advertising, Marketing and Promotion (AMP) expenses, and outstanding receivables, were correct and in accordance with the Income-tax Act, 1961 (the Act) and relevant Transfer Pricing (TP) provisions.
- Whether AMP expenses constitute an international transaction and whether they lead to creation of marketing intangibles, thus warranting transfer pricing adjustment.
- Whether the inclusion or exclusion of certain comparable companies in the TP study for benchmarking international transactions was appropriate, including the validity of comparables such as Syngene International Limited and Sequent Research Limited.
- The applicability and correctness of the benchmarking methods and filters applied by the TPO and AO, including the use of Transaction Net Margin Method (TNMM), profit level indicators, and the application of the Bright Line Test (BLT).
- Whether the interest on outstanding receivables from Associated Enterprises (AEs) constitutes an international transaction warranting adjustment under transfer pricing provisions.
- The appropriate benchmark interest rate for payment on ECBs - whether the London Inter-Bank Offered Rate (LIBOR) or State Bank of India Prime Lending Rate (SBI PLR) should be applied, and the correctness of the credit rating assigned by the TPO in the absence of actual credit rating data.
- Whether the principle of consistency in transfer pricing adjustments should apply, especially in light of prior years' orders on similar issues.
2. ISSUE-WISE DETAILED ANALYSIS
A. International Transaction of Contract R&D Services
Legal Framework and Precedents: The determination of ALP for international transactions is governed by sections 92C, 92CA, and 92D of the Act, read with Rule 10D of the Income-tax Rules, 1962. The principle of arm's length price requires comparability analysis considering functions performed, assets employed, and risks assumed. Prior decisions emphasize the need for appropriate selection of comparables and filters.
Court's Interpretation and Reasoning: The Tribunal examined the TPO's rejection of the assessee's comparables and substitution with new comparables, including Syngene International Limited and Oxygen Bio Research Private Limited. The assessee challenged the inclusion of Syngene International Limited on grounds that it is functionally dissimilar and lacked segmental information necessary to ascertain comparability.
Key Evidence and Findings: The Tribunal scrutinized the financial statements of Syngene International Limited, noting the absence of segmental revenue breakup between contract research and manufacturing services. Reliance was placed on a prior Tribunal decision that excluded Syngene as comparable due to lack of segmental data and functional dissimilarity.
Application of Law to Facts: The Tribunal held that without segmental information, the TPO's filters (e.g., service revenue constituting over 75% of operating revenue) could not be verified or satisfied. Thus, Syngene International Limited could not be included as a comparable. The Tribunal directed exclusion of Syngene and recomputation of TP adjustment accordingly.
Treatment of Competing Arguments: The Revenue urged remand for verification of segmental data; however, the Tribunal found no infirmity in the CIT(A)'s order excluding Syngene. The assessee's contention was accepted, rendering other sub-grounds academic.
Conclusion: The Tribunal allowed the assessee's appeal on this issue, excluding Syngene International Limited from comparables and directing recomputation of ALP.
B. Advertising, Marketing and Promotion (AMP) Expenses
Legal Framework and Precedents: Section 92B defines international transactions, and the applicability of transfer pricing provisions to AMP expenses has been judicially examined. The Hon'ble Delhi High Court in Maruti Suzuki India Ltd. and Sony Ericsson Mobile Communications India (P.) Ltd. held that AMP expenses do not constitute international transactions under section 92B and thus are not subject to transfer pricing adjustments.
Court's Interpretation and Reasoning: The TPO treated AMP expenses as international transactions, asserting that such expenses benefit the AE's global brand and thus warrant adjustment. The CIT(A) deleted the additions, following prior Tribunal and High Court rulings in the assessee's own case and other precedents.
Key Evidence and Findings: The Tribunal noted the consistency of facts and nature of business across years and the substantial judicial authority holding AMP expenses as non-international transactions. The Tribunal also observed that the assessee incurred AMP expenses exclusively for its Indian market sales enhancement.
Application of Law to Facts: Applying the principle of consistency and judicial precedents, the Tribunal upheld the CIT(A)'s deletion of AMP-related TP adjustments.
Treatment of Competing Arguments: The Revenue's arguments about the scale of AMP expenses and their benefit to the global brand were rejected as insufficient to overcome binding precedents and factual consistency.
Conclusion: The Tribunal dismissed the Revenue's appeals on AMP expenses, confirming that such expenses do not constitute international transactions under the Act.
C. Interest on Outstanding Receivables
Legal Framework and Precedents: The question whether interest on outstanding receivables constitutes an international transaction has been considered in Nimbus Communications Ltd. vs. ACIT and Indo American Jewellery Ltd., where it was held that a continuing debit balance is a consequence of an international transaction but not an international transaction per se.
Court's Interpretation and Reasoning: The Tribunal noted that the assessee did not charge interest on receivables from either AEs or non-AEs, and no adverse impact on profits or assets was demonstrated. The CIT(A) deleted the adjustment accordingly.
Key Evidence and Findings: The Tribunal relied on the absence of interest charging practice and the uniform treatment of related and unrelated parties.
Application of Law to Facts: The Tribunal applied the principle that transfer pricing adjustments on interest require demonstration of impact on profits or assets, which was lacking here.
Treatment of Competing Arguments: The Revenue failed to provide contrary material, and the Tribunal upheld the CIT(A)'s deletion of the adjustment.
Conclusion: The Tribunal dismissed the Revenue's appeal on this issue.
D. Benchmarking of Interest on External Commercial Borrowings (ECBs)
Legal Framework and Precedents: Transfer pricing provisions require benchmarking of interest rates on international borrowings. The choice of benchmark rate (LIBOR vs. SBI PLR) and credit rating assumptions are critical in determining ALP.
Court's Interpretation and Reasoning: The assessee contended that SBI PLR was appropriate for inbound loans used in India, and LIBOR plus arbitrary credit spreads applied by TPO were incorrect. The TPO applied LIBOR plus 600 basis points with an assumed credit rating due to lack of actual rating data.
Key Evidence and Findings: The Tribunal acknowledged the loan agreements and interest rates paid by the assessee, and that the credit rating was assigned without basis.
Application of Law to Facts: The Tribunal agreed that LIBOR is the proper benchmark for such loans but remanded the matter to the AO to obtain actual credit ratings before finalizing the adjustment.
Treatment of Competing Arguments: The Revenue supported the TPO's approach citing absence of credit rating data; the Tribunal found this insufficient to uphold the arbitrary credit rating assignment.
Conclusion: The Tribunal partly allowed the assessee's appeal, directing re-examination of credit rating and benchmarking methodology.
E. Purchase of Raw Materials and Intermediate Goods
Legal Framework and Precedents: Transfer pricing requires determination of ALP for purchase transactions, considering the functional profile of parties and appropriate tested party selection under TNMM.
Court's Interpretation and Reasoning: The assessee claimed that it is the key decision-maker assuming market risks, and overseas AEs are routine manufacturers; hence, the assessee should be the tested party. The TPO held the opposite, making adjustments.
Key Evidence and Findings: The Tribunal noted that in prior years, similar transactions were accepted without adjustment, and the circumstances remained unchanged. The assessee also challenged the inclusion of International Bakery Products Ltd. as comparable, citing functional dissimilarity and incorrect margin calculations.
Application of Law to Facts: Applying the principle of consistency and examining the comparability issues, the Tribunal deleted the adjustment on purchase of raw materials. The exclusion of International Bakery Products Ltd. was also upheld.
Treatment of Competing Arguments: The Revenue's support of the TPO's findings was not found sufficient to overturn the CIT(A)'s order.
Conclusion: The Tribunal allowed the assessee's appeal on this issue.
F. Inclusion of Sequent Research Limited as Comparable
Legal Framework and Precedents: Selection of comparables must be based on functional similarity and satisfaction of applied filters.
Court's Interpretation and Reasoning: The assessee successfully demonstrated that Sequent Research Limited met the TPO's filters and was functionally similar. The Revenue's request for remand for further verification was declined.
Key Evidence and Findings: The CIT(A) and Tribunal found no reason to exclude Sequent Research Limited.
Application of Law to Facts: The Tribunal upheld the inclusion of Sequent Research Limited as a valid comparable.
Treatment of Competing Arguments: The Revenue's contention for remand was rejected.
Conclusion: The inclusion was confirmed.
3. SIGNIFICANT HOLDINGS
"In absence of segmental information and functional dissimilarity, the company Syngene International Limited cannot be included as a comparable for determining the arm's length price."
"AMP expenses incurred by the assessee do not constitute an international transaction under section 92B of the Income-tax Act and therefore, transfer pricing adjustments on such expenses are not warranted."
"A continuing debit balance in the account of associated enterprises does not amount to an international transaction per se for transfer pricing adjustment, unless it is shown that it impacts the profits, incomes, losses or assets of the assessee."
"The benchmarking of interest on external commercial borrowings should be based on appropriate credit rating data, and arbitrary assignment of credit rating without basis is not justified."
"The principle of consistency requires that transfer pricing adjustments should not be made in the current year when similar transactions in prior years were accepted without adjustment, unless there is a change in facts or circumstances."
"Inclusion of a comparable company in transfer pricing analysis must be based on satisfaction of all applied filters and functional comparability; where these criteria are met, such inclusion should be upheld."
Final determinations:
- The assessee's appeal on contract R&D services was allowed by excluding Syngene International Limited and directing recomputation.
- The Revenue's appeals on AMP expenses were dismissed, confirming AMP expenses are not international transactions.
- The Revenue's appeal on interest on outstanding receivables was dismissed.
- The assessee's appeal on benchmarking interest on ECBs was partly allowed, remanding for obtaining credit rating data.
- The assessee's appeal on purchase of raw materials was allowed, deleting adjustments.
- The inclusion of Sequent Research Limited as comparable was upheld.
- Appeals for AY 2014-15 to 2016-17 were decided following the principles established in AY 2013-14, largely dismissing Revenue's appeals and partly allowing assessee's appeals.
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